Wednesday, February 29, 2012

Most people that do that want to use their (lack of) size to find (and exploit) value-priced small cap stocks.

The problem is that almost any company with a market cap of $200 million to $5 billion has teams of private equity (PE) buyers looking at it.

The competition is fierce.

The PE guys have two advantages I do not. They have access to cheap loan funds in quantity. And when they do a transaction they can get inside the company, look at the books and do proper due diligence.

Those are winning advantages - advantages that I would not want to compete against.

One arguable offset to those advantages is that many PE executives are surprisingly inept. They look good in their suits - but I have met a few along the way who really are empty suits. You know the type - straight out of their big-name business schools but without the depth of experience and the humility to know that business can be difficult. For the purposes of investing they are stupid.

Their stupidity however is masked because mistakes are not marked-to-market. A bad transaction can be buried a long time and a few good ones (with lots of leverage) can offset a lot of ills.

I don't understand why so-called "value investors" are drawn to small caps. Trying to find cheap stocks against stupid people backed by seemingly limitless cheap funds and no market discipline does not seem like a good way to construct a value portfolio.

Sunday, February 26, 2012

I consider myself a bit of a Buffettphile - but I did not even know Berkshire had a sizeable agricultural machinery operation. Sure agriculture has been good and because the capital equipment is a lean off that it has been very good. But this throw-away quote from the annual letter is astounding:

Vic Mancinelli again set a record at CTB, our agricultural equipment operation. We purchased CTB in 2002 for $139 million. It has subsequently distributed $180 million to Berkshire, last year earned $124 million pre-tax and has $109 million in cash. Vic has made a number of bolt-on acquisitions over the years, including a meaningful one he signed up after year end.

This business has - in a decade - distributed well over 100 percent of its purchase price in cash to Berkshire and its pre-tax earnings are roughly the acquisition price.

Of the thousands of listed companies in the world how many have been that good in the last decade. Surely not many.

I promise you I am not telling anyone anything new here. If you are an investor in the solar-panel industry and have not noticed a supply glut then you are completely non-observant.

What is strange though is that despite the supply glut the capital expenditure in this business - that is building new plant and machinery - goes on regardless.

Here is a line from the balance sheet:

Trina Solar Limited

Unaudited Consolidated Balance Sheets

(US dollars in thousands)

December 31,

September 30,

December 31,

2011

2011

2010

Property, plant and equipment

919,727

783,328

571,467

Property plant and equipment at Trina went from 571 million to 920 million in one year. And in the year when the industry became hopelessly oversupplied.

Moreover the rate of increase accelerated in the fourth quarter when the oversupply was obvious to anyone to see - when anti-dumping cases against loss-making Chinese solar panel makers became vogue.

There are lots of things that might be going on here. The company might have a great new technology which is worth investing in even though the industry is glutted (indeed the company points to its "honey" technology). Or the company might be insane. I have my thoughts but I do not have enough knowledge to be certain.

But one friend suggested that this is just an analogue for all of China. Who cares if office buildings are glutted? Just build more. Who cares that the high-speed-rail between two cities you have never heard of, a railway line that consumed valuable steel and concrete by the millions of tonnes is mostly run at a third capacity with empty trains? Build more.

"Build it and they will come" may be the Chinese mantra. Usually only works in Hollywood films.

John

PS. I should disclose that Bronte still has a short-biased straddle on Trina - but it is a much smaller position. We closed a fair bit for profit - but traded that bit not so well. I should have covered the short end more aggressively when the stock was $6.

What amazed me though was the returns of Titanium Asset Management. It was limited according to its documents to being long-short the stocks in the ASX200 (an index of the top 200 companies in Australia). These were the monthly returns as reported:

These returns are astounding. 40 percent in October 2008, 20 percent in February 2009. Magic numbers really.

So I rang the fund manager - Peter Rice - to try and work out how he did it. I did not understand - at least it did not make sense to me so I reported my concerns to ASIC.

I did make an effort though. I found an interview with Peter Rice on Sky News (repeated below). That made no sense either.

Anyway I put it out of my mind.

A couple of weeks ago I looked again. Here are later returns.

The early months had all gone. (No more 40 percent months!)

The return in February 2009 had gone from plus 20 percent to minus 7 percent.

I was puzzled.

I rang the auditor as listed in the original product disclosure status. He sounded sorry for me - wondering if I was an investor in the fund. He told me he had never been the auditor and had gone to some lengths to let the regulator know that he was falsely listed as the auditor.

I rang Peter Rice and he told me the original returns came from "paper trading". I wondered why he did not tell me that the first time I rang and he said that he did not believe he was under an obligation to disclose that. (Indeed when I rang him the first time he told me that he had an independent back office and used Citigroup as his prime broker - both things that would not occur if the profits were from paper trading.)

I sent it all to the Sydney Morning Herald. (My job is to manage money - not explore these things...)

He also pointed out something that truly surprised me. Andrew Blanchette who controls Titanium (at least is listed on the license and is the owner of the domain names) was once the boyfriend of Sydney model Caroline Byrne. She was found dead at the bottom of Sydney suicide spot The Gap. Maybe suicide. Maybe murder.

Caroline's death was the subject of much gossip in Sydney - the prime suspect was Gordon Wood. Wood was Caroline's boyfriend at the time of her death and was also the chauffeur to Rene Rivkin a colourful Sydney stockbroker. Rivkin has since committed suicide.

If this gets past the just-laugh stage I worry for American democracy. If this actually happens we know the scope for corruption in America is unlimited.

If the DOD wants to part with its valuable spectrum just auction it. Giving billions of dollars to fading - soon-to-be-bust hedge funds. That is beyond any semblance of decency.

Phil, for the sake of decency and because you are ultimately a patriot - just put Lightsquared in Chapter 11. Leave the corrupt obtaining of public assets to Chinese billionaires and Russian Oligarchs. You are better than that.

Wednesday, February 15, 2012

Alan Sokal, a Professor of Mathematics at University College London and a Professor of Physics at New York University published this in Social Text - a peer reviewed left-wing journal of post-modern thought published by Duke University Press.

But deep conceptual shifts within twentieth-century science have undermined this Cartesian-Newtonian metaphysics1; revisionist studies in the history and philosophy of science have cast further doubt on its credibility2; and, most recently, feminist and poststructuralist critiques have demystified the substantive content of mainstream Western scientific practice, revealing the ideology of domination concealed behind the façade of ``objectivity''.3 It has thus become increasingly apparent that physical ``reality'', no less than social ``reality'', is at bottom a social and linguistic construct; that scientific ``knowledge", far from being objective, reflects and encodes the dominant ideologies and power relations of the culture that produced it; that the truth claims of science are inherently theory-laden and self-referential; and consequently, that the discourse of the scientific community, for all its undeniable value, cannot assert a privileged epistemological status with respect to counter-hegemonic narratives emanating from dissident or marginalized communities. These themes can be traced, despite some differences of emphasis, in Aronowitz's analysis of the cultural fabric that produced quantum mechanics4; in Ross' discussion of oppositional discourses in post-quantum science5; in Irigaray's and Hayles' exegeses of gender encoding in fluid mechanics6; and in Harding's comprehensive critique of the gender ideology underlying the natural sciences in general and physics in particular.7

To Sokal the article was a modest (though admittedly uncontrolled) experiment: Would a leading North American journal of cultural studies -- whose editorial collective includes such luminaries as Fredric Jameson and Andrew Ross -- publish an article liberally salted with nonsense if (a) it sounded good and (b) it flattered the editors' ideological preconceptions?

The answer was unfortunately yes.

And it was self-evidently nonsense. The quote I give you above includes that physical "reality" [and note the "scare quotes"] no less than social ``reality'', is at bottom a social and linguistic construct. Sokal invites "anyone who believes that the laws of physics are mere social conventions to try transgressing those conventions from the windows of [his] apartment. (He lives on the twenty-first floor.)

I will observe when the physics has something useful to say and its an argument between left-wing social theorists and conventional physics the physicist wins. Conventional physics is (at least within the distances and energy levels we can measure) very settled science - and to say novel things you need to go to minute sizes or massive energy levels (as per the Large Hadron Collider).

The Sokal hoax was funny - but it was hardly necessary. The social sciences whose response to hard science is to deny it are best ignored. Unless you have Alan Sokal's sense of humour it is not even that much fun teasing them.

Anyway - this sort of anti-science based obscurantism has historically been the province of the Left. I mean who other than a left-wing loopy intellectual would think that the reality described by conventional physics is a social construction - a conspiracy of physicists. And a physical reality they can save you from by deposing the hard (and testable sciences) so they can install themselves as a priest-class who understand this social construction stuff (not to mention the obscure jargon in my opening quote).

Oh I know who gives these self-indulgent and self-important left-wingers a run for their money. The new anti-science conspiracy theorists are on the right. Evolutionary biology is a conspiracy of godless liberals who want to undermine God's laws. Climate change is a conspiracy to allow Government more control over your life.

It is funnier when it is a bunch of academics. History has a way of sending the loopy ideas of academics to the obscurity they deserve. It is less funny when it is politicians.

But this is not a blog about the anti-science elite in politics and academia. Its a blog mostly about financial markets and their goings on and all the crappy things you can invest in.

When people in financial markets behave that way - believing their socially constructed reality over physics - then it is time to go short them.

But when you see this stuff in markets you have just got to short it. I know rich people who are usually smart who invested in Blacklight Power. I just could not work out a way of shorting it.

It requires a special-brand of delusion to construct your world such that basic science does not apply to you. Its the brand of delusion that the fools from Social Text have. Its the brand of delusion that some of America's more loopy right-wing politicians have.

Alas it is also the brand of delusion that Phil Falcone has. It was the brand of delusion which powered Lightsquared.

The physics of radio interference is settled. This is physics at ordinary distances and ordinary energy levels. (To find non-settled physics you need to shorten the distances and raise the energy levels as per the LHC.)

We know this stuff.

We know that if you put a low power radio station near a high powered radio station the high-powered station causes interference. We understand resonances between different frequencies.

As I said - this stuff is settled.

But that did not stop Phil Falcone investing his clients money in a loophole - an attempt to take spectrum which was allocated to low-powered devices (satellites) and wish to use it for high-powered devices (mobile phone towers) and to think everything would be OK. I wrote about it recently - but have had the view for some time. And it was in contradiction to physical reality (and this time I did not put "reality" in scare quotes because that reality is really real).

Phil Falcone is almost certainly smarter than the idiots who edit Social Text. But years of success and the strange cocoon of being a Wall Street billionaire got Falcone to the point that he thought that reality did not apply to him.

He became just like the most loopy of left-wingers.

Still Lightsquared is dead - the FCC has now determined that the conflicts with GPS are not able to be resolved. That is a fatal blow to Lightsquared (and I am glad). It means that parts of the government (like Defence who value their GPS) still have a say and that anti-science obscurantism is not everywhere - just on the far-left, far-right and in the minds of some particularly self-indulged Wall Street types.

This new board member is probably very good at spin - which will be useful as the company tries to persuade the New York Stock Exchange to reinstate its listing.

Here is her CV:

Ms. Moling Shang has served during her career in several jobs in the communications division of the Central Committee of the Communist Party of China (CPC). From 1984 through 1996, Ms. Shang was the Chief of the Propaganda Department in the Information Bureau of the CPC's Central Committee. From 1996 to 1999, Ms. Shang served in numerous positions including Associate Director of News Agency for China Central Television and her previous role as the Chief ofPropaganda. Following her successful completion of her previous roles, Ms. Shang was appointed Deputy Chief of Propaganda in the Organization Department of the CPC Central Committee where she was responsible for the Three Represents campaign from 1999 through 2002. From 2002 to 2010, she served as Deputy Chief of the Information Bureau of the CPC Central Committee. Ms. Shang graduated from the Branch School of Peking University.

She is the former Deputy Chief of Propaganda of the Information Bureau of the Communist Party of China Central Committee.

Sunday, February 12, 2012

Warren Buffett recently wrote an article in Fortune (a cut from his forthcoming shareholder letter) which explains why he prefers owning businesses (either outright or through the stock market) than owning currency based investments (bonds, cash) or gold.

Buffett's writing and thinking is a model of clarity. Kid Dynamite's highlighting and analysis is a worthy follow-up.

Buffett does not like bonds or cash as investments because they are (in his view) unlikely to retain their real value over the medium to long term. In God we Trust - but the hand that activates the printing press is human. Buffett defines investment return in real goods and services - investment is putting away some spending power now in the expectation of having more spending power later. Bonds and cash make nominal returns. Buffett thinks real returns are unlikely and disastrous outcomes are possible: "[currency based investments] are among the most dangerous of assets. Their beta may be zero, but their risk is huge".

Quoting Shelby Davis he notes that at current yields currency based investments offer return free risk.

Though unstated you can tell Buffett does not predict a Japanese outcome. Twenty years of deflation would make bonds a fantastic investment by Buffett's criteria. That is a possibility he does not even entertain...

Buffett is not fond of gold either - waxing lyrical on its uselessness. The world gold stock if melded together would fit in what he views as a useless 68 foot cube. Think of it as sitting comfortably in a baseball infield.

And he notes the extraordinary value of that cube. At current prices that cube would buy all the agricultural land in the United States, sixteen companies as valuable as Exxon and leave you a trillion dollars in walking-around money. He cannot imagine why you would prefer own the cube than the alternative assets. Similarly he can't imagine why you would want to own a bit of that cube than an equivalent bit of the alternative assets.

Over the next century 16 companies as valuable as Exxon will have thrown of trillions in dividends - and the agricultural land will have thrown off huge quantities of wheat, corn, beef and other valuable commodities.

The gold will just sit there.

The best line in the article is one of Buffett's sexual zingers: you can fondle the cube, but it will not respond.

He is right of course. Some people think that gold is a good investment because it has retained its value (measured in agricultural land) for centuries. That is all the proof you need that the investment is stupid. The agricultural land had a yield all that time. The gold probably got stolen - and had no yield.

Buffett's prescription: own productive assets.

And that is good advice if you pick productive assets with competence. If you don't I think the Buffett prescription can be a recipe for disaster.

You see the gold does not have free-will - or any will for that matter. Fondle it and it does not respond.

Stocks and businesses however have people running them - and people range from clever to inanely stupid. Integrity levels cover the spectrum from someone you would hope would marry your daughter to Bernie Madoff.

Willie Sutton robbed banks because that is where the money was. Now the money is on Wall Street. If Willie Sutton was reincarnated he would come back as some Wall Street scumbag (or an investment banker). And on Wall Street he would almost certainly not be prosecuted. People who rob banks get prosecuted. People who steal via the stock market not so much.

Because the scumbags go where the money is Wall Street is particularly thick with scumbags. Wall Street has tens of thousands of Willie Suttons.

Fondling stocks can be very profitable if you know what you are doing - especially over very long time periods. But the proviso is there ... if you know what you are doing.

And gold is pretty easy to understand. It just sits there. People however are difficult to understand and sometimes dangerous - and people and the stock market are intertwined. And you are more likely to find a scumbag in the stock market than internet dating (the scumbags have Willie Sutton motives).

If you do not know what you are doing fondling stocks can be either as much fun or as dangerous as fondling people. Some may respond by being nice back. Some will spike your drink, lift you wallet and sodomize you on the way out.

Mr Buffett makes it seem simple. I love reading him - but sometimes I think he is dangerous because he makes it seem so easy that it lulls people into a false sense of security...

John

PS. Positions: no gold. Long companies with high levels of management integrity and decent valuations. Short scumbags, slimeballs and villains. Names can be left out of this piece.

Thursday, February 9, 2012

Today the company made a repetitive press release that has me reading between the lines. Here is the guts of the release:

[The company] today announced that the Audit Committee of its Board of Directors has substantially completed its investigation of the Company's accounting for certain crop payments to walnut growers. The Audit Committee has concluded that the Company's financial statements for the fiscal years 2010 and 2011 will need to be restated. Over the course of the last three months, the Audit Committee has carefully reviewed the accounting treatment of certain payments to walnut growers. The Audit Committee has concluded that a "continuity" payment made to growers in August 2010 of approximately $20 million and a "momentum" payment made to growers in September 2011 of approximately $60 million were not accounted for in the correct periods, and the Audit Committee identified material weaknesses in the Company's internal control over financial reporting.

The Board of Directors is taking a number of corrective actions including the appointment of a new Chief Executive Officer and Chief Financial Officer. Effective immediately, the Board has appointed Director Rick Wolford to serve as Acting President and Chief Executive Officer and Michael Murphy, of Alix Partners, LLP, to serve as Acting Chief Financial Officer. The Company is commencing searches for permanent replacements for the CEO and CFO positions. The Board has also appointed Robert J. Zollars, who previously served as Lead Independent Director, to the position of Chairman of the Board. Michael J. Mendes and Steven M. Neil have been placed on administrative leave from the Company.

I have read the whole release - but there is no additional information.

I know relatively little about this company - indeed I did not bother looking because the short was crowded and the product (Kettle chips and walnuts) seemed OK. But this release had me puzzled.

The offence as described - moving $20 million of expense from one year to another in one year and $60 million in another year seems relatively minor. But the sacking of the CEO and CFO and the appointment of Alix Partners seemed less minor.

Still timing offences (and they admit timing offences) must be measured relative to earnings.

The last 10K (since amended and now withdrawn) shows nicely growing income in excess of $50 million.

$26 million in net income and about $50 million in the next year. If you were to add $20 million of expense to 2010 and $40 million (the net amount moved) to 2011 and tax-effect those amounts the profits drop from a net $26 million to $14 million for 2010 and $50 million to $22 million for 2011.

That is pretty nasty. But not terminal. Still there are 21 million shares outstanding and at the after-market price ($21 down 42 percent) that is still 20 times earnings.

It does not look like a salivating buy at 20 times. Not close.

And the loss of the CEO and CFO does matter. There is seldom only one cockroach.

The thing that gets me though is the appointment of the new CFO. Michael Murphy is from Alix Partners and his CV makes it very clear that he specializes in restructuring debt. Alix do a lot of bankruptcy work (though that is not the only thing they do).

The last balance sheet (also since withdrawn) is amusing.

It shows cash of just over $3 million, some short term debt and long term obligations of nearly half a billion dollars. And - given the restatement - we can guess this thing only earns just over $20 million a year - and even that presumes the absence of further cockroaches.

I shorted some in the after-market. Don't do that often - but am quite pleased with myself.

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The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.